Specialist background
- Around 20 years in the HVAC industry with extensive knowledge in terms of growth outlook, key drivers of this growth considering new regulations nationally, the impact of the coronavirus, population changes or movement to the sunbelt, and a transitioning workforce
- Co-owner at an air conditioning repair shop with an annual turnover of USD 20m for brands including Carrier Trane, York Rheem, Goodman and Mitsubishi
- Well-versed with market size for HVAC equipment as well as the competitive landscape of key manufacturers and product offerings
Questions
1.
Let’s start off at a very high level. I'm still trying to build my knowledge base on the space. Let’s start off with a couple of very basic questions. I'm guessing, if you come from a background that has private equity involvement, these would be pretty basic questions, but curious if you could help me define the HVAC market a little bit. How big is it, generally? How much of it would you attribute to new construction activity vs your aftermarket repair and replacement? What percentage do you consider more residential in nature vs more commercial in nature? Let's start with a couple of high-level questions there.
2.
I'm just curious, obviously the industry has seen a couple of crazy few years since the onset of COVID. If you could put that aside for a second, over the past decade, what would you typically have said normalised growth rates would have been in the industry? I'm guessing it follows residential and commercial construction cycles, but is it more of a GDP-type growth that you would see in the industry, on a normalised basis?
3.
How would you describe the normal replacement cycle for, I don't know if you would differentiate between heating systems and cooling systems, but is it typically a 10- to 15-year replacement cycle, assuming things don't break down before that?
4.
Let me just clarify that a little bit. Basically, if I am buying over a home second-hand, let's say owner A was the first guy who moved in, he got a warranty for 10 years. In year two, he decides to sell the house to me. I move in as the second owner. The warranty is no longer eight years, but it gets knocked down to five years, is what you're saying?
5.
Perhaps on a related note then, you mentioned at the beginning of our discussion that, beyond the building codes, stuff that we just talked about, there were also other regulatory changes that might be driving the market from a more secular perspective. Perhaps you could double-click on some of those policy changes or regulatory changes. I don't know if it's SEER changes in 2023, whether that's the IRA bill, would just love to hear about some of those factors at play.
6.
Before we go back to the supply chain issues, that's going to be one focus area, let's talk a bit about the market landscape. Just trying to get a better sense of who the biggest players are in the HVAC industry, at least on the manufacturer side. Some of the big public players that I've heard of are Lennox, Carrier, Trane, maybe JCI more on the commercial side. Anyone else who I'm missing? I would just love a better understanding of what their applications might be in the industry, or what they're strong at. That would be a good segue into some further questions.
7.
The product goes from the manufacturer, they make it, they have their own wholly-owned distributors, that goes to you, the contractor, and then it goes to the end customer?
8.
I think you were alluding to this as well, but Watsco also carries non-carrier brands?
9.
These five or six large OEMs, would you say that represents, what percentage of the market would they represent? 80%? I'm just trying to get a sense of how concentrated…
10.
If you're an end customer, when I think about key purchasing criteria, what are the most important factors to me? Is price the primary basis of competition, or do people care about aftermarket, reliability, servicing, all that? What are the key factors? When I want to choose a HVAC system across the five or six OEMs out there, who do I go with?
11.
How does this tie into, at the beginning of the discussion you made reference to these building code changes that don't allow you to replace individual components, which was driving people towards replacing the entire unit or the entire system. It does sound, from the most recent comments, that there's a good amount of just replacing individual parts and components if that was the only thing that needed to be changed.
12.
You also mentioned earlier the industry has typically grown 6-9%, high single digits, on a normalised basis. Just curious, how much of that is price vs volume? My follow-up question was going to be, with this IRA and a bunch of other secular tailwinds behind the industry, what sort of bump would you expect that to provide to normalised growth rates over the next decade, I guess absent any economic recession, that we'll be able to get to in a bit?
13.
Who provides that financing? Is that obtained directly from the banks, or do the OEMs or the contractors help you secure those?
14.
A lot of our discussion so far has centred on, I believe, the residential side of the market. Would you say those comments are also similarly applicable to the commercial side, in terms of getting financing programmes in place? Just wondering, for commercial or industrial customers, because I think that has so far been a safe harbour within the broader industry still. Just wondering if tightening up credit conditions would similarly roll over to those end markets as well.
15.
It seems like supply chain hasn't normalised as much on the commercial side, relative to the residential side. Feels like residential side, trying to get product through has been a bigger focus for the OEM.
16.
What about people who, let's say, January, February this year, still want to do a project? Does the whole supply chain situation make them take a pause and defer those projects? Why would you expect commercial to be down? I know lead times are going to be long (talking over each other).
17.
In the commercial market, how much of it is repair and replacement vs new instals, again? Just wondering if the skew is different there.
18.
There is really more replacement activity on the commercial side, usually, but I guess in this environment we're in, you might actually see people shift from replacement to repair and try to expand the lifespan of the existing (talking over each other).
19.
Within this broad umbrella of commercial, I would guess that there a couple of different end markets within this umbrella. Would you just help me understand the different dynamics at play here? For example, I think data centres and warehouses, that has been a pretty strong market over the last couple of years, just given the boom in e-commerce and all that. Just wondering, what percentage of the market would you normally attribute to the commercial real estate vs industrial complexes, vs warehouses, data centres? Just wondering how the market splits itself up in order to cut up the pie.
20.
Just wondering what your outlook for the market was at the end of 2022. You can feel free to deviate between the residential market and the commercial market. If I were to ask you, December 2022, what has been your best guess for how revenues would perform in 2023? Maybe you can split that between price vs volume, in both residential vs commercial. I guess that's (talking over each other) question.
21.
Just to clarify again, you said volume down now, or volume up 1-2%?
22.
I'm just wondering if your comments on volume were slightly driven by where you are based regionally. I don't know if you guys are a nationwide contractor, and things might be different in different parts of the country. Just help me understand that dichotomy (talking over each other).
23.
A quick question on the topic of backlogs. Does this concept exist in the HVAC space, or, given what you said earlier on the just-in-time production and trying to get things shipped as soon as possible, do you place a lot of value on the idea of backlogs in this business, or does that (talking over each other).
24.
Going back to the topic on pricing, industry has obviously taken a lot of price, and you made a good point on margins probably looking pretty good this year. I'm just wondering, you've been in the industry for a very long time. In prior downturns, what happens to the price in those scenarios? Do people give back pricing, just given how the people compete largely on price as one of the key factors? Would you expect price to be given back if that gloomy recessionary scenario were to play out, or would you expect manufacturers to be able to hold onto that pricing?
25.
Coming back to your overall outlook again, please feel free to correct me if I'm wrong, but it feels like you're turning incrementally more positive on the residential side of things and incrementally more bearish on the commercial side of things. Is that fair to say?
26.
Do the incentives and rebates that you talk about as it relates to the heat pumps, does that also extend to commercial and industrial customers, or are those incentives only relevant for the residential end market?
27.
I'm just wondering if you could help me understand, maybe in prior down cycles, how much did the replacement market dip and how much did the aftermarket side go up, in the opposite direction? Just trying to get a sense of how they balance out. Obviously, it's going to be a net negative, I think, just given that the replacement market has bigger tickets, but if you could give me a sense of how those two parts move, it would be very helpful.
28.
We have talked about your market outlook earlier, with resi up, I think you said, like 4-5%, commercial up but slightly lower than that. That was your outlook, I believe, at the end of 2022. Has your perspective changed now that we are close to the end of Q1? Would you say it's gotten worse, gotten better or status quo, the same view that you had at the end of 2022?
29.
Have you seen that happen yet? Have you seen projects getting put on hold yet, or is that your intuition, looking forward?
30.
Just remind me, your business footprint is mostly the southern part of the US or you have a national footprint?
31.
Let me press you on that a little bit, because your outlook, the revenue numbers that we went through, you've held those numbers the same and didn't revise your outlook for the rest of the year. If things do get as bad as you say they might potentially get, would you still expect commercial to be up low single digits and residential to be up 4-5%, or just to completely flip and go negative growth?
32.
Would you expect their fates to reverse, given the dynamics you talked about? Stating the obvious, if you have higher commercial exposure, given your outlook, you'll probably have more of a negative view on a manufacturer that has a larger commercial footprint, and Lennox, which has a higher residential footprint, I'm guessing, you'd be a bit more optimistic on their prospects?
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